From Crisis to Confidence: Spanish Banks Ready to Shine

If we thought turmoil in the financial sector, as well as troubled banks, was no longer a concern, then we were in for a rude awakening earlier this year. Regional banks in the US, along with the Swiss giant Credit Suisse, encountered difficulties. Thankfully, swift actions taken by central banks and politicians prevented these issues from spreading to major banks in the US and across Europe.

This can be partly attributed to the lessons learned from the Global Financial Crisis, which severely impacted banks in Europe. Presently, the banking sector is resilient, benefiting from two driving factors: regulation and market consolidation.

Regulatory reforms at the European level, notably Basel III, have played a crucial role in enhancing the financial stability of European banks. These reforms served to mitigate risks for the banking sector, otherwise prevalent in previous economic cycles.

One of the countries this is evident within, is Spain. When looking at Spanish banking sector under a microscope, we see the qualities of a more stable banking sector.

Consolidation as a key factor

Highly concentrated banking markets with strong market structures tend to exhibit greater stability and have more profitable institutions. Spain serves as an example of successful market consolidation following the Global Financial Crisis.

The Spanish banking sector underwent significant restructuring, transforming from a highly fragmented market to one in which five banks today control 67% of the retail lending market and over 80% of the deposit market.

Since 2008, the number of credit institutions in Spain has halved, indicating a substantial market consolidation, only being surpassed by the Netherlands and Cyprus which are two countries with the highest degree of consolidation in Europe.

Risk profile

The level of risk banks have on their balance sheets plays a pivotal role in determining their resilience during economic cycles. In Spain, the banking sector was greatly exposed to real estate lending and developers leading up to the Global Financial Crisis and leverage in Spain reached 170% of GDP. This was significantly higher than the Euro area average of a little over 100%.

Since then, Spain has reduced its debt. Currently, the level of debt in Spain is 93% of GDP and in line with the average for other European countries. Compared to Sweden, the United Kingdom, and France, we can see that Spain’s current leverage level is significantly lower. In Sweden, leverage is 203% of GDP, while UK is leveraged 148% of GDP, and France is at 124% of GDP.

Improved financial flexibility

Financial flexibility is not solely determined by the risks a bank takes, but also by whether it receives fair compensation for those risks and possesses the earning power to withstand losses through credit cycles.

The financial flexibility of a banking sector can be measured through revenue strength, cost efficiency and absorption of credit risks. In this regard, Spain’s banking sector demonstrate positive performance.

Spanish banks are highly geared towards the rising interest rates with 70% of the housing stock priced on a variable rate basis. This has improved Spanish bank revenues positively, as the interest rates have climbed upwards and will continue to do so. Another positive development is loan to deposit ratios, which are down from 120% in 2010, to current 94%, allowing for more flexibility on the pass through of funding costs.

Compared to core European countries, the cost structures of Spanish banks have remained stable, with an average efficiency ratio of 51% compared to 69% for French banks, 74% for German banks, and 48% for Sweden, which are leaders in this respect.

Strong cost efficiency and revenue strength enhance the capacity to absorb increased risks. Spanish banks also perform well compared to other core European countries in pre-provision capital generation which is currently 3.38%, compared to 2.4% in France and closely approaching Sweden's 3.5%.

Spain shows the path to financial stability

The recent challenges faced by regional banks in the US and Credit Suisse remind us of the importance of a stable financial sector. Fortunately, lessons from the Global Financial Crisis have left a stronger banking sector in Europe where Spain serves as a prime example.

The positive development in Spain is driven by consolidation and efforts to reduce debt levels and improved financial flexibility. This has positioned Spanish banks more favorably compared to their European counterparts. Spanish banks rightfully deserve recognition for their accomplishments.